Why 0% APR credit is bad for your health

Recently we've been inundated with "0% APR" offers from various credit card companies. After trying two of them out, and being very disappointed, I finally sat down and read all the fine print. And I figured out what should have been obvious at the beginning:

0% APR is only good for the credit card companies. It's very bad for an individual consumer's financial health.

Today, before I shredded it, I read in detail the terms of the new "0% APR" Discover Card we received in the mail. Unfortunately, it's mulch now, so I can't refer to the exact verbiage, but here are the terms they are not specific about:

Your billing cycle is a 25-day cycle, not 30 or 28. This means that, even though they offer a low "0% APR" on purchases, that only applies for the first 25 days of the purchase. I'll show you why, in combination with the "balance transfer" deal, this is a racket which enormously benefits the credit card company. But at the heart of the system, if you pay your bill on the same day every month, it's impossible to avoid paying interest on purchases.

That billing cycle gives you a moving target for payment every month. Some months, you'll be paying early in the month, some months, you're later in the month. Some months, you'll have to pay TWO payments (one towards the beginning, one towards the end) in order to keep current and avoid late fees and immediate invalidation of your 0% APR! Can you afford two credit card payments a month? This keeps you off-balance, and more likely to lapse into the "default" terms of your credit card, which will usually double or triple your monthly payment.

Balance transfers. Oh, these seem like a holy grail for people who, like us, ended up owing a lot on a credit card due to medical expenses while uncovered by health care, and have yet to dig themselves out. Here's how they actually work, and how that "0% APR" offer is a sweet investment for your credit card company.

The 0% APR, even if it's "for life", is actually for a limited period, no matter what. You have to jump through some extraordinary minutiae to keep that APR... minutiae which involves racking up consumer debt without any way to pay it off until your 0% APR loan is paid off.

There's a minimum $5.00 to $50.00 balance transfer fee which is immediately applied to your credit card at the CASH ADVANCE rate. That's 28% interest, and since it's at the "cash advance" rate (the highest rate), it will be both the first loan taken out, and the very last one paid off.

The terms of this Discover card specify that, once the "term" ends, in order to keep the low APR, we'd have to make THREE minimum qualifying purchases or cash advances every month. A minimum qualifying purchase is one that is at least $50.00, and has a rate around 10%, or 28% for cash advances. So you have a $150 minimum purchase requirement every single month.

The heart of the racket is this: you always pay off your lowest-interest loans first. Let's say you have a $10,000 balance to transfer. At "0% interest", you'll have a payment around $90 per month, which includes a little interest on that $50 "cash advance" you took out to get the balance transfer in the first place. That little bit of interest is basically the equivalent of the fees they aren't charging you. It's only a few bucks a month, but it pays for itself for the credit card company.

Balances which carry a 0% interest rate aren't subject to the same restrictions on payments that balances with interest are. Nice little loophole in the law: they don't need to make you make 3% minimum payments! This means that, if the rates we've seen before are any indicator, at the default payment rate, it's going to take you TEN YEARS to pay off that 0% interest balance.

Add it all up: you have $50.00 which is going to sit in there for probably the life of the loan. Once your term expires, you have to spend $150 a month on the card, which you aren't allowed to pay off until you've paid off your 0% loan. This means that your monthly rate is going to keep creeping up until you've paid the thing off! If your "term" is, say, three months, that means that for the first three months, you are going to have a nice, low $90 payment. Then every month thereafter until you have paid off that balance transfer, your payment is going to creep up by about $5.00. Since you are not allowed to actually pay off those high-interest balances until your low-interest balance is paid off, you're screwed.

Here's the math on this one. You do a $10,000 balance transfer at "0% APR". You fulfill the bizarre payment requirements to the letter, and you start out your loan with what you think is a sensible payment of $170 a month... WELL above the minimum payment they expect. This would pay off that $10,000 in five years, right?

Sure. The first year, everything is going well. You make your fifteen payments (remember that 25-day billing cycle you have to remember?) Heck, you overpay, because like most sensible people you assume $170 a month, and actually end up paying two extra payments in the year. "Cool," you think, "my balance is down to $7960".

Well, not really. You have that little $50 that you're forbidden to pay off. $8010. Plus interest on that $50 for the first year, which adds another $66.00 to your balance (well, it fails to subtract $66.00, so the same difference). $8076. Well, it's not such a bad deal. For $116, you just paid off a year of debt interest-free. Woohoo!

Then the "three purchases a month" rule kicks in. OK, you'll play their little game. That second year, you rack up an extra $1800 in consumer debt you're not allowed to pay off until you've paid off the stuff you aren't getting charged any interest for. You're still kicking in $170 a month, but the equation has changed: in that time, you just racked up an extra $2K on your credit card, and...

...Congratulations. You are now in the hole $1,000 more than when you started. And your "generous" $170 a month contribution towards your 0% debt now barely covers the interest on your loans.

What a scam.

So put yourselves in our position: a substantial amount of consumer debt, which is mostly because we converted medical debt to credit card debt, along with substantial periods of unemployment during the "bust". Believe it or not, we got better terms from a credit card company for paying off a massive hospital bill than we did from the hospital.

What strategy would you take to getting rid of that debt in 5 years or less?

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It looks like the real kicker in that is the forced purchases a month after the APR period is done. The 25 days is a bit of a hassle, but not impossible for someone to stay one step ahead of.

As you say, folks like us are inundated with 0% APR offers. Why not bounce them? Wait till one CC reaches its APR expiration, then transfer over to a newly opened card, and close the first one.

Yes, the 50 dollars with interest hurts a bit, and moving from CC to another doesn't look great on the Credit report, but in a deep in the hole situation like $10,000 in, the credit report's going to take a hit regardless, isn't it?

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What we chose to do was consolidate into a small home-equity line of credit through our credit union. The interest is relatively low, the terms are easy, the payments are automatic if we forget to make them (through our credit union), and even if we maxed it out, we're still looking at a very reasonable payment.

Of course, the default is interest-only, which sucks :) So we're not doing that. To get rid of it in five years, we did a time-value-of-money calculation, and figured out what payment we'd need to make in order to get rid of a certain amount of principal every month while paying the modest interest. We're on track, and should have it all gone by 2011. As long as we don't keep putting home improvements on the card or something.

We now have exactly three debts left, out of a list of quite a few more a few years ago: Our home, our car, and our home-equity credit. We finally manage just fine now that we have established a sound budget. It only took a dozen years for us to figure it out :)

I'm looking for your advice with getting a new credit card. Unlike Matt's rant over card interest program (0% or low APR) I'm trying to find a card that has the best rewards program.

For many years I've had all my charges run through an airline rewards card. The reason for sticking with this type of loyalty program is because MPLS is dominated by Northwest. Northwest owns 80% of the gates at the main terminal in MPLS. Sticking with a credit rewards program that keeps piling on the miles made sense, especially with the ability to get a free ticket on a 6 month cycle. Even though Northwest's redemption threshold at 25,000 miles clearly is inferior to Southwest's fly-4-get-the-5th-free threshold, I held steadfast to the prevailing business community belief that airlines-based credit cards were the best credit card programs available.

Oh, how things change quickly.

About two months ago Northwest pretty much withdrew general availability for their 25,000-mile rewards seats. It's like the only way to fly on a reward ticket now is cashing in 50,000 mile points. Since the credit card reward program works on $1 per mile, Northwest is telling me that through their bank relationship I have to spend $75 each year for the right to hold the card, then $50,000 with the card to get a free ticket, and then another $25 to redeem the 50,000 miles for a rewards ticket. If the round trip ticket happens to cost $1,000 then I will have spent $100 for the right to get a 2% cash-back equivalent on having spent $50,000.

I'm telling Northwest to go screw themselves.

That's why I'm looking for a new credit card. Each month I pay off the full balance. I carry no finance charge; APR is not an issue. Balance transfer is not an issue either. I want no annual fee. Although I'm open to learning about retail and point-based rewards programs, I'm thinking that because of the rewards hike by Northwest, that 'points' are never what they seem. Cash back programs seem pretty good right now, but that's why I'd like outside opinion.

Previously, in other posts, Matt has called Chase Manhattan a "bottom-feeding, scum-sucking algae eater of a company." Assuming that opinion has not changed, I'm considering the following:

Having been a Rewards Card member through my credit union for several years, I tend to agree that the "reward" is infinitesimal compared to the expenditure. And if you don't plan well in advance, the reward-point-flight may cost you as much or more as a regular flight.

And they don't cover fuel surcharges via reward points. Doh.

I will only say that Visa seems to be accepted far more places than American Express. I've used my AmEx twice in the past three years; my Visa gets pretty much a daily workout.